What are investment-grade corporate bonds?
Investment-grade corporate bonds are debt instruments rated BBB- and above by Standard & Poor’s. Other rating agencies have their own scale to rate a corporate bond as investment-grade. Treasuries are also considered investment-grade.
Mutual funds such as the Vanguard Total Bond Market Index Inv (VBMFX) help you to invest in these instruments. The VBMFX invests in investment-grade corporate bonds of companies such as Apple (AAPL), American Airlines Group (AAL), Nike (NKE), and General Electric (GE).
Yield movement in 2015 so far
According to the BofA Merrill Lynch US Corporate Master Effective Yield, yields had fallen from January to mid-April 2015, primarily because of a rise in safe-haven demand for investment-grade bonds, as there was a lot of turbulence in European markets due to the economic crisis in Greece.
By mid-April, yields on investment-grade corporate bonds had fallen to a low of 2.84%. US corporates and financials thronged the primary bond market in the US due to these low yield levels. However, from the end of April through mid-May, yields showed a rising trend, though their levels remained lower than those seen in 2014.
June broke the trend, and yields have been rising since then. The major reasons for the rise in yields are the possibility of an interest rate hike by the Federal Reserve, an uncertain global growth outlook, and rising uncertainty in China. Yields had risen to as high as 3.52% on September 16. This was not only the highest level in 2015 year-to-date, but also the highest level since September 18, 2013.
A potential interest rate liftoff may hurt high-grade issuers, as higher interest rates lead to lower bond prices and increased borrowing cost.
Meaning and importance of spreads
The BofA Merrill Lynch option-adjusted spread, or OAS, measures the average difference between yields of investment-grade bonds and Treasuries. Securities selected for calculating this spread are those rated BBB- or higher on the rating scale of Standard & Poor’s.
If spreads are rising or widening, credit conditions can be assumed to be worsening. Spreads also widen when growth is slow and economic conditions are worsening. Conversely, falling or tightening spreads coincide with faster growth and with better economic conditions.
How have spreads moved until September 2015?
In 2015, spreads had fallen until the end of April, but they rose in May, June, July, and August. Through September 25, spreads ranged between 1.29% and 1.72%. In 2014, spreads by this measure had ranged between 1.06% and 1.51%.
The OAS averaged 1.50% in January 2015. The average fell in February, March, and April to 1.43%, 1.35%, and 1.33%, respectively. However, from May onward, the average OAS began to rise. Spreads averaged 1.34% in May, 1.42% in June, 1.51% in July, and 1.65% in August. So far in September, spreads have averaged 1.68%. Further, spreads are up 26 basis points compared to the end of December 2014.
In the next article, we will look at the deals and volumes of investment-grade corporate bonds.